Large Contractors Cast A Bigger Shadow

There have always been BIG contractors. But now, as a result of the roll-up trend and other drivers, there are more of them - and they seem to loom larger in the electrical contracting industry's future. This is Part Two of a multi-part series that began in January.

For the time being, the consolidation trend that was all the rage in the electrical and mechanical contracting industries has slowed. In late 1999, with the announcement of a merger of two of the publicly held "roll-up" companies, the excitement seemed to cool.

How, then, can one assess the impact of the 1998-99 period of consolidation? What has happened? What kinds of entities are now competing with your company? And where are they going?

Essentially, where there was, perhaps, only one very big electrical contractor in 1996, there are now three. As it turns out, very big ECs can have more opportunities than most companies in the history of this business, especially in the areas of national accounts on voice/data/video work.

What follows is a look at the companies, what they have done, and what they might do - with an emphasis on how these consolidators will change the industry's future.

EMCOR Group

Look at Engineering News-Record's list of the Top 50 Electrical Contractors for 1990, and you find JWP - the forerunner of EMCOR - as number one, with $970 million in sales. Number Two, Fischbach & Moore, has almost $370 million.

Find the list for 1994, and EMCOR is on top, with $1.0 billion; Fischbach, at $430 million, is still second. And 1996's list puts EMCOR at $901 million, down a bit in sales, but ahead of SASCO Group, in the No. 2 spot, at $348 million.

What's more, the same tale could be told on the mechanical contracting side. JWP's mechanical operations were built in much the same way as its electrical - via an ultra-aggressive acquisition campaign. So EMCOR topped the list of mechanical contractor sales, too, for the 1990s.

Fast-forward to 1999: EMCOR in a bit more than a year acquired companies with roughly $700 million in annual sales, more than half of which came via the buy of Poole & Kent, a Baltimore-area mechanical contractor that has been in the top 10 on that side of the fence.

Combining mechanical and electrical operations is part of the company's strategy of morphing into a "facilities service" organization. With more than 18,000 employees and offices around the world, EMCOR can go to a client and offer worldwide (or just nationwide) services. The strategy "is to differentiate ourselves from pure construction companies that live and die with the cycles of new construction," according to Frank MacInnis, the company CEO, in a late-October interview with Reuters.

An endorsement

Has the strategy worked? Standard & Poor's, which evaluates corporate debt, in December reevaluated EMCOR and upgraded its outlook to "positive" from "stable." S&P's statement reads like an endorsement of the EMCOR approach:

* "outsourcing and vendor rationalization, which are occurring in a variety of North American industries. These trends should lead to further national account business, which is viewed as favorable, as it is reoccurring and does not result in material price degradation to the industry."

* "EMCOR uses mostly unionized labor, which helps the company attain more complex jobs and secure work in urban locations. This results in a healthy percentage of sales from retrofit work."

* "The company is expected to increase its facility services business, which currently accounts for about 20 percent of sales."

* "Growth will come internally from bundling facility services with EMCOR's construction services and from acquisitions."

* "Acquisitions will likely be made to add additional geographic reach and gain economies of scales in the company's North American facilities service operations."

Another indicator that EMCOR's approach is working is, of course, its financial results. The company crossed the *2-billion barrier through only nine months of 1999, with an *810-million quarter. Four $800-million quarters in a row would make EMCOR a $3.2-billion company!

Plain speaking

While EMCOR reportedly remains interested in acquisitions, company executives like to differentiate it from the late-1990s-era roll-ups in the electrical and mechanical business. Here is an excerpt from the Sept. 6 edition of The Air Conditioning Heating & Refrigeration News - an interview with Jeff Levy, president/COO of EMCOR:

"We went through the consolidation process already. Now we are seeing consolidators pay a lot of money for these businesses. They can't let them alone to do their own thing.

"They will look for value from integration. This is not a forgiving market. Paying a lot for a company puts a lot of pressure on future performance.

"You have to create an interactive business model and structure. I'm not sure how you integrate all these different companies into one. In a couple of years, when the stock deals are vested, former owners may want to take their proceeds and leave."

What's most scary about EMCOR is not its collective opinions, however, but the scale it can bring to smaller contracts. If there is a threat to most electrical contractors from EMCOR, it comes from the company's ability to do just about anything it wants, including bundling facilities services to win a job, or serving national accounts, or almost anything else. Note that, according to MacInnis, the company does $1 billion a year in projects of under $250,000 each.

GroupMAC & Building One

A merger of two roll-ups was scheduled to consummate last month. Group Maintenance America Corp. (Houston) and Building One Services Corp. (Wayzata, Minn.), were to combine into a mega-contracting entity on a scale with EMCOR. Essentially, the new company will:

* be heavily into the facilities services area, combining mechanical, electrical, and janitorial contracting
*gross more than $3.2 billion in annual sales
* have operations in each of the top 100 markets in the United States
*get more than 50 percent of it sales from maintenance, repair, and replacement, and
*initially have 43 percent of its sales, or more than $1 billion, in electrical contracting.

When the merger is completed, it will mark a diversion from the 1998-99 consolidation craze in electrical and mechanical contracting. As executives of the two companies said, in conference calls with Wall Street analysts when the merger was announced:

"We really have become a true operating company . . . I don't believe it is appropriate any more to look at us as a consolidator--we have consolidated a great deal of the country . . . we are an operating company."

And: "We'll still be an acquisitive company--but . . . (we won't be) out there now trying to gain mass, as both Building One and GroupMAC were trying to do independently . . ."

Fewer acquisitions

Essentially, what the merger means is a reduction in the number of buyers ready to acquire mid-sized to large electrical and mechanical contractors. Up until the two companies agreed to get together, it looked like the consolidation binge would roll on for quite some time - with at least Building One and GroupMAC, as well as IES (see below), as willing buyers.

Why? Each of the two companies had said they were pursuing similar strategies: To offer (at least) mechanical and electrical contracting services in (at least) the top 100 markets in the U.S. Both were handicapped by the performance of their stock on the open market. It's important to remember that a "classic" roll-up company or consolidator will pay for acquisitions with a combination of cash and stock . . . often as much face value of stock (or more) than actual cash. However, both companies ran into a brick edifice called Wall Street.

Building One had been the subject of some financial maneuvering by its founder, Jon Ledecky of Washington, D.C.; within 18 months, Ledecky turned his $126,000 initial investment in the company (made before it went public) into more than $50 million. In order to do that, an April 1999 stock buy-back by the company took place - draining off some needed-for-acquisitions cash and leaving Building One in debt.

GroupMAC had run into problems on Wall Street, it would seem, in being understood. The company had originally promoted itself to investors as targeting maintenance work, but as it acquired various companies over time, the percentage of revenues coming from maintenance would vary.

What's more, during 1999 it became apparent that earlier roll-up companies in the HVAC-mechanical side of the market were failing. American Residential Services, the first to come public (in 1996), was purchased at a price less than 40 percent of its initial public offering; Service Experts, another HVAC-mechanical consolidator, also was punished by the stock market, falling from a high of $38 per share to be ultimately taken over at a fraction of that. And Comfort Systems, an HVAC consolidator of more recent vintage, also brought in results under expectations.

Tarnished with the broad brush of "contractor roll-ups aren't working out," the stock prices for GroupMAC and Building One stagnated at extremely low levels. This greatly reduced the value for each company of its own stock as "currency" in acquisitions - and, it would seem, led to the merger.

Sea change

Assuming the merger is completed, the new GroupMAC will be able to offer its three services - electrical, mechanical, and janitorial - to corporate customers in 43 of the nation's top 100 cities. That gives the new company a jump-start on reaching the top-100-city market that each had craved independently.

However, the new entity will have electrical contracting operations in only 47 of the top 100 cities, a figure dwarfed by its mechanical operation (in 83 of the cities). Therefore, some additional acquisitions in electrical contracting can be expected.

What's threatening to most contractors about the new entity is its growth rate. The mechanical and electrical services of both GroupMAC and Building One were posting year-over-year double-digit increases via "organic" or internal growth (also called "same store" increase - i.e., growth without adding in the affect of acquired companies).

Assuming for a second that the new merged entity is able to sustain double-digit internal growth, that would mean that, without acquisitions, GroupMAC could tack on as much as $300 million in sales in 2000. Add in another $300 million for acquisitions, and the company could be a $4 billion "facilities services" giant by 2001.

Disregarding the numbers, the new GroupMAC is a potential threat to any contractor with business from a "national account"-type company. Consider: Building One had relationships with the telecommunications firms Reltec (installing DC power for its operations) and Marconi Communications. GroupMAC had, just before the merger announcement, agreed to link up with a Web-based facility cost-reduction operation, The Cadence Network. All of these arrangements, if sustained, now become more potent.

Another threat: At Building One, national accounts made up about 12 percent of the pre-merger revenues - and most of that was, the company said, coming from its janitorial operation. But the company claimed that the men and women running the janitorial operations were clamoring for mechanical and electrical contractors to be added to the company, because they saw great opportunity for cross-selling to the same national accounts they were already serving.

A bottom line here is that the post-merger GroupMAC could very well be larger than EMCOR Group, and could also have expansion possibilities the likes of which no one in the electrical construction business has ever before seen. Additionally, the hunger for acquisitions of the new entity is but a fraction of the earlier buying needs of the two companies separately configured.

Integrated Electrical Services

While EMCOR and the new GroupMAC are targeting facilities services, bundled services, and cross-selling of services combinations, one original consolidator stands alone, in that it hasn't merged, hasn't declared bankruptcy, and is devoted solely to electrical construction: Integrated Electrical Services (Houston).

IES, which did not exist until a January 1998 initial public offering of its stock, finished fiscal year 1999 (on Sept. 30) with its first $1 billion-year. In that 12-month period, IES bought 40 companies, which together had annual sales of about $415 million; the buyers took the purchase price, on average, as 45 percent cash, 55 percent stock. Going forward, IES says sales are running at an "annual run rate" of about $1.2 billion, and that it has a target of adding $300 million in revenue via acquisitions.

Add in double-digit internal growth, and it's possible that IES could top $2 billion in sales in two years (in terms of actual sales and annualized sales of acquired companies). However, the company has noted that FY 2000 (began Oct. 1) would be one in which "we increase ever more our focus on integration, implementing best practices, and realizing synergies," in the words of Jim P. Wise, the company's CEO.

Significantly, the company in a Nov. 11 phone conference with Wall Street analysts focused a great deal of attention on "higher-margin, fast-growing information technology and power line markets." By "information technology," IES means the voice/data/video marketplace.

Here's what the company has said it is doing or will do in this area:

IT work was 8 percent of FY 99 revenues the company's goal for 2003 - to have 17 percent of its revenue in the IT field - is being moved up, and "we have a good shot at exceeded that . . . possibly even in fiscal year 2000."

"We're turning away . . . three times as much work as we're doing" in the IT field, in the words of Jerry Mills, who was the company president at the time.

IT acquisitions?

Mills also said, later in the same phone conference, that IES had "a staggering amount of opportunities (in IT) that we're currently negotiating on today, far more than I think we're capable of executing. So we'll be selective and try to get some really good work in that area."

With more work than it could handle, IES was shifting some of it acquisition focus. As of the November phone call, IES was talking with 20 companies that did IT work - or voice/data/video - about acquisitions. Together, the companies had roughly $500 million in annual sales; eight of them (with $100 million in sales together) had signed confidentiality agreements with IES, which meant that discussions about the acquisitions had made some significant progress.

Wise indicated to analysts that, while the average multiple paid for electrical contracting companies was 4.4 times EBITDA - earnings before interest, taxes, depreciation and amortization - IES would pay more ("north of five") for voice/data/video acquisitions. "Let me tell you, for good companies, we don't mind paying," he added.

Pre-fab revolution?

One of the elements that IES brings to any market in which it is a competitor is creativity. The company was founded as an extension of "peer group"-type meetings fostered by a non-union contractor association. The real-world net of this, in competing with IES, is that a good practice developed by one of the IES companies can be quickly extended to many of them - including the one in your marketplace.

Consider prefabrication. Many have talked about prefab before in the electrical field, but few have pursued it as avidly as IES. In early 1998, only four of the 16 contracting companies that founded IES had prefabrication operations in place; now 25 of the company's 75-plus local operations are doing prefab work, with 300,000 square feet of indoor production space.

"We believe that every hour allocated to prefab manufacturing can save us about one and one-half hours of field time," Mills has said.

A bottom line on IES, for now, seems to be that it will continue to acquire companies, but perhaps, with a bigger inclusion of voice/data/video specialists in the mix. With its plans for double-digit internal growth and a creative approach to the industry's production work, the company's gains are certain to come from someone else's hide.

What about utilities?

What's missing in the above tales of acquisitions is the entire trend that sees electrical utilities buying mechanical and electrical contractors including, lately, power line contractors (including GPU of New Jersey's purchase of MYR Group in late December). The story of what utilities appear to be doing, individually and as a group, will appear in this space in the May issue of Electrical Contractor.

However, it's noteworthy that the three companies above (counting GroupMAC and Building One as one entity) should together have roughly $4 billion in electrical contracting sales in 2000, in a market that EC magazine estimates at nearly $90 billion. At this point, then, the combined threat of these giants is not necessarily frightening to every electrical contractor . . . just the mid-sized to larger ones in whose markets they have chosen to compete.

Salimando is a Vienna, Va.-based freelance writer; e-mail him at JSALI@cris.com. His twice-monthly column on current industry news, The Web Prowler, can be read on EC Magazine's Web site: www.ecmag.com

A Quick Look At Other Players

While IES, GroupMAC and Building One made the headlines in the 1997-99 heyday of consolidation in electrical contracting - and the JWP/EMCOR entity for a lot longer than that - there have been other companies playing the field as well. Here's a brief look at a few of the noteworthy names:

Nationwide Electric: for a young company, Minneapolis-based Nationwide has an incredible history. Formed early in 1998 by a subsidiary of Kansas City Power & Light - a utility - Nationwide never got very far. The reason: a prolonged period of enforced inactivity on the merger front, as Nationwide twice failed to have the public buy its stock via an IPO.

Essentially, KCP&L wanted to sell off much of its holdings in Nationwide, after putting several companies together. Thanks to poor timing (the first IPO was scheduled for August-September 1998, exactly when a market break occurred), this couldn't happen. So the utility did the next best thing. It sold Nationwide in September 1999 to Bracknell Corp., a Canada-based consolidator.

Bracknell Corp.: Bracknell is positioning itself as a facilities services company, and owns The State Group, a significant force in Canadian contracting. Thanks to the $76.7 million purchase of Nationwide, it reportedly has more than $500 million in electrical and mechanical contracting sales - more than half of which come in the U.S.
Railworks: This company describes itself as "a leading nationwide provider of integrated rail system services and products." However, the company's subsidiaries include L.K. Comstock, a leading electrical contractor!

Railworks had $137 million in sales in a recent quarter, indicating a $500-million-plus annual sales rate; Comstock's sales for 1997 (the last year on which hard numbers are available) were $137 million, indicating that electrical contracting could well make up a third of this company's activities.

Other relevant consolidators, including Quanta Services and Black Box Corporation, will be covered in future reports in this series. - Joe Salimando